Not only did IndyMac Bancorp Inc. report awful fourth-quarter earnings last week, but it outlined a turnaround plan that was met with a dose of skepticism.
The Pasadena-based lender is betting on its ability to transform its mortgage production model, which has long been based on making home construction loans and so-called Alt-A loans, which are loans between prime and subprime.
The new model is based on originating loans to borrowers with prime credit and selling them to government-sponsored agencies such as Fannie Mae and Freddie Mac but analysts warned that the bank company faces a difficult transition.
"They are doing the right thing by overhauling the business model to an agency business, but it will be an uphill battle," said Matthew Howlett, vice president of Fox-Pitt Kelton, an investment bank in New York.
One of the steepest obstacles for IndyMac is that the new strategy calls for a well developed retail branch network. Most of IndyMac's business has been based on a wholesale platform that relies on brokers and other banks that shuttled it business.
A year ago IndyMac spent $13.4 million to purchase the retail mortgage platform of New York Mortgage Trust, taking over 21 full-service and 11 satellite offices across 11 states. That will help, but the plan is counting on dramatic growth.
It projects making $1.16 billion in loans from its retail channel in the first quarter way up from only $49 million in the first quarter last year. It is an open question whether it can go that far that fast against the many competitors doing the same thing.
"It will be difficult for IndyMac to compete against the retail banking franchises and produce the quality and margin needed to generate an acceptable return on investment, given their expense structure," Howlett said.
Also, loans that are sold to government-sponsored entities, or GSEs, typically are less profitable than Alt-A loans a pitfall IndyMac acknowledges but claims it has incorporated into its strategy.
"GSE lending has lower margins, but it also involves lower risk and we can sell these loans faster," said Michael Perry, chairman and chief executive of IndyMac, in a letter to shareholders on Feb. 12.
Regardless, IndyMac's plan received a boost Feb. 13 when President Bush signed an economic stimulus package that includes a provision to temporarily raise the cap on loans that GSEs can buy from $417,000 to $729,000. That should be of particular help in Southern California, where homes are expensive.
Cost reduction is one of the key components to the new business plan. In January, the company announced plans to lay off about one quarter of the workforce, and further layoffs may be on the horizon.
"We feel like we have made the cuts in employment that we need to make, but we can't guarantee that we won't have to go further," said Grove Nichols, director of corporate communications for IndyMac.
Facing a tsunami of bad mortgage loans, the nation's second-largest independent mortgage lender last week reported a net loss of $509 million, or $6.43 a share, for the fourth quarter 2007. It also reported its first annual loss.
Weighing like dead ballast on the balance sheet are bad loans, which are expected to reach 7.5 to 8 percent of total assets in the second half of 2008, up from 0.63 percent at the end of 2006.
"Looking at the acceleration in (bad loans), it is a pretty dramatic increase," said Jason Arnold, a research analyst with RBC Capital Markets investment bank in San Francisco.
IndyMac boosted its reserve to pay off bad loans to $2.4 billion, a four-fold increase from a year earlier. "We have the capital to absorb nearly triple our presently forecasted 2008 credit costs and fight our way through until the housing and mortgage markets stabilize," Perry said in a statement.
Still, RBC Capital Markets downgraded IndyMac's stock to underperform after the earnings report was released.
"We have a very challenged housing market combined with economic weakness, and that does not bode well," Arnold said. "The loans they have on their balance sheet (include) Alt-A, interest-only and pay-option loans, and loans to home builders. That will wreak havoc on earnings in 2008."
Shares of IndyMac Bancorp closed at just over $8 on Thurs., down 78 percent from a 52-week high of $37.95.
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